Income inequality is holding back the economy, says S&P

Income inequality has been the topic of vigorous debate this year from Thomas Piketty’s breakdown of the issue in his best-selling book, “Capital in the Twenty-First Century,” to President Obama’s campaign for a higher minimum wage.

Everyone has a central question: Is income inequality holding back the U.S. economy?

“The current level of income inequality in the U.S. is dampening GDP growth,” the researchers wrote, “at a time when the world’s biggest economy is struggling to recover from the Great Recession and the government is in need of funds to support an aging population.”

The data isn’t necessarily new, but the series of charts makes salient and concise arguments as to what’s been driving the trend and the impact it could be having on economic growth.

U.S. incomes are becoming more concentrated. This is typically shown using a Gini coefficient, a measure of income distribution and thus income inequality. A higher number means the gap between top and bottom earners is getting further apart, which is the trend we’re seeing over the last several decades.

Not only do the affluent have higher incomes, but they also tend to save more of what they earn instead of spending it. That means that as more of the nation’s income goes to top earners, the less gets passed around the economy in the form of spending. There isn’t enough demand for goods and services to prop up strong growth.

Trying to drive the gap in demand with debt creates the boom-bust cycle, which can further push down bottom earners by depleting wealth.

The solution? Education, according to the researchers.

By boosting education growth rates to those seen in the mid-20th century, meaning if the U.S. workforce gained a year’s equivalent of education over five years, the nation’s GDP would be 2.4% higher over that time period than otherwise.

There’s one catch. More people with college degrees would mean more people competing for higher-paying jobs.

Short term, the competition could slow wage gains for those with post-secondary degrees as more people compete for a set number of jobs. But that would help those lower down the education spectrum catch up on pay as the economy gains steam from increased output.

Essentially, it would squeeze inequality to a more manageable gap.

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